How to Calculate the Discount Factor for a Company

by Jim Clayton, Demand Media

Net present value is crucial for determining the time value of money when evaluating long-term projects. Use net present value to help evaluate profit and losses in today's dollars, based on future payments. The key number needed to determine net present value is the discount factor, the factor by which future monies received are multiplied to obtain net present value.

Step 1

Determine the periodic interest rate in decimal form. This is found by dividing the annual interest rate by the number of payments made per year. For example, if the annual interest is 6 percent and payments are made monthly, then the periodic interest rate is (.06/12) = .005.

Step 2

Find the total number of payments to be made. Let's assume a company will pay off its debt in three years. The number of payments would then be (3x12) = 36.

Assign variables to each number. For example, P = periodic interest rate and n = number of payments.

Step 4

Calculate the discount factor (D) using the formula D=1/(1+P)^n. Replace the variables with your data. In the example above, the formula to find the discount factor would be D=1/(1+.005)^36.

Step 5

Solve the equation. In our example, the result would be (1/1.1966)=0.8357.

Things Needed

Calculator

Tip

To determine present value for the future payments, multiply the amount owed by the discount factor. For example, if the company was owed $100,000 over the three years in our example, then the net present value would be $100,000 x 0.8357, or $83,570.

About the Author

Named Industry Leader of tomorrow by Electronic Media magazine
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Guest on CNN Moneyline and the McNeil-Lehrer News Hour

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